The globetrotter's portfolio: Canadian investors should seek returns beyond their own backyard

Hey there, time traveller!This article was published 18/7/2014 (874 days ago), so information in it may no longer be current.

In the grand scheme of the investment universe, the Canadian market is not insignificant, but it does still represent a small sliver of all the opportunities out there.

Yet many Canadians are happy to stick to their own backyard, although they don't totally avoid other markets.

Recent research by Vanguard Investments Canada -- the Canuck arm of one of the world's leading exchange traded fund (ETF) companies -- found the average stock market allocation by Canadian investors to Canadian investments is about 65 per cent.

"When you consider the Canadian market makes up only three per cent of the global market, that shows that we're very overweight in Canada," says Atul Tiwari, managing director of Vanguard Investments Canada.

"And when you look at fixed-income bonds in Canada, it's actually even worse."

When it comes to bonds, Canadians' homegrown exposure in their portfolios sits at 87 per cent, he adds.

Certainly, publicly traded Canadian companies do have exposure to international opportunities. Many of our oil and gas, banking and mining firms do a lot of business elsewhere in the world.

But sticking close to home means your investments may be a lot less diversified than they probably should be, and how the Canadian economy goes, so, too, does your portfolio.

"There are high consumer-debt levels. The unemployment numbers are heading in the wrong direction. Then, we think the Canadian equity market is overvalued as well," he says.

"You put those things together and it doesn't look to good for Canadians focusing just on investing in Canada anymore."

A good alternative has always been the U.S. because it's easy for Canadians to invest directly in its stocks markets, and investing in the U.S. offers global exposure in many ways. For one, it makes up almost 50 per cent of the capitalization weighting of all the world's stock markets, Tiwari says.

You also get good diversification in terms of asset allocation. The U.S. has major players in just about every industrial sector from energy and financials to technology and health care. Adatia says the U.S. also has better economic prospects than Canada even though its stock markets are breaking record highs of late -- usually an indication they could be overvalued and poised for a decline.

"But there's a lot more room for markets to move up because the economy is strong and the U.S. consumer is quite strong as well," he says.

Investing in the U.S. also provides access to companies with global reach that are doing business in emerging markets. While this may appear to be a good substitute for direct exposure to these markets, these companies likely don't do enough business in emerging markets to truly capture the growth of these rapidly expanding economies, says Luc de la Durantaye, managing director of asset allocation and currency management with CIBC Asset Management.

"You may have a U.S. company with 20 to 30 per cent of its operations in emerging markets," he says. "But if you really want to have the full exposure to the emerging market growth, then some direct exposure to emerging markets is probably warranted."

He adds the case is much the same with developed markets like Japan and Europe.

One major obstacle, however, is actually getting exposure to foreign markets. While some individual stocks of major foreign firms -- such as Indian automaker Tata Motors, or French energy firm Total -- are traded on the New York Stock Exchange, it's very difficult for small investors to get access to foreign stocks and bonds and build a properly diversified portfolio on their own.

Bonds are particularly difficult, Tiwari says.

"Trying to buy bonds in Europe and other international locations is really next to impossible as a small investor," he says. "You don't get scale, and pricing really isn't that transparent."

Consequently, your best bet to get foreign exposure -- beyond the U.S. -- is through investing in mutual funds or ETFs.

Both have their respective advantages and disadvantages.

Mutual funds generally offer investors access to managed portfolios of stocks and bonds. Fund managers build portfolios of investments, buying and selling based on each investment's merit. Some experts argue this strategy is better for investing in foreign markets, especially emerging ones like China, India, Indonesia, Brazil and Russia.

"The question you have to ask yourself is 'Where are the most inefficient markets?' " de la Durantaye says.

"Although there have been more and more managers coming into the space, the emerging markets still have a lot of market inefficiencies, so going active is probably not a bad choice."

The idea being managers do the research and hopefully weed out the bad companies as opposed to a passively managed mutual fund or ETF that simply tries to emulate the performance of an emerging market index -- like the MSCI Emerging Market Index -- which will include bad and good apples alike.

"People believe that as a stock picker you might have an advantage in some of these less developed markets, but our research shows that in reality, you're still going to be better off buying the broader market at a low cost than trying to choose a hot manager who might have outperformed in the last year or two," Tiwari says.

Passive and active strategies aside, increasing your portfolio's share of global investments is worth considering because it allows you to put more of your eggs in several different baskets instead of just one.

As we move toward an increasingly globalized marketplace where some regions' economies grow like weeds while others stagnate, spreading your money around a little bit might turn out to be a lucrative portfolio strategy in the long term.

giganticsmile@gmail.com

Returns by region

Below are the annual average returns on investment for several regions, including Canada, the U.S. and the world as a whole.

World markets (without U.S.):

Annualized real returns (accounts for inflation and other factors):

2000 to 2013: 1.7 per cent equities; 5.3 per cent bonds

1964 to 2013: 5.6 per cent equities; 4.8 per cent bonds

1900 to 2013: 4.5 per cent equities; 1.6 per cent bonds

European markets:

Annualized real returns (accounts for inflation and other factors):

2000 to 2013: 2.5 per cent equities; 7 per cent bonds

1964 to 2013: 6.2 per cent equities; 4.8 per cent bonds

1900 to 2013: 4.4 per cent equities; 1.1 per cent bonds

World markets:

Annualized real returns (accounts for inflation and other factors):

2000 to 2013: 1.7 per cent equities; 5.3 per cent bonds

1964 to 2013: 5.4 per cent equities; 4.1 per cent bonds

1900 to 2013: 5.2 per cent equities; 1.8 per cent bonds

U.S. markets:

Annualized real returns (accounts for inflation and other factors):

2000 to 2013: 1.8 per cent equities; 4.9 per cent bonds

1964 to 2013: 5.8 per cent equities; 3 per cent bonds

1900 to 2013: 6.5 per cent equities; 1.9 per cent bonds

Canadian markets:

Annualized real returns (accounts for inflation and other factors):

2000 to 2013: 3.9 per cent equities; 5.3 per cent bonds

1964 to 2013: 5.1 per cent equities; 3.8 per cent bonds

1900 to 2013: 5.7 per cent equities; 2.1 per cent bonds

How do emerging markets stack up with the developed world? Relative to developed markets since 1900, emerging markets have lagged behind in growth until 2000 to 2009 when annualized returns on investment in emerging markets was a little over 10 per cent compared to almost zero growth for developed markets. But in the last three years, developed markets have outperformed emerging markets by almost 10 per cent a year.

-- Credit Suisse

Our piece of the market pie:

Credit Suisse also produced in its report data on the relative sizes of stock markets by nation.

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